2018 Portfolio Playbook

The global economy appears to have entered a new phase — one of synchronized sustainability — but markets have been rising, and much of the good news is reflected in asset prices, particularly in the U.S. These conditions raise a number of questions heading into 2018: Where are we in the economic cycle? Is the U.S. priced for perfection? Have investors missed the rally in European equities? Will rising inflation impact asset prices? Here are key investment themes to consider and guidance on positioning portfolios for 2018:

Equity Themes

Equity portfolios at Capital Group are constructed through individual security selection based on fundamental, bottom-up global research, rather than top-down tactical shifts. Through this bottom-up process, a number of themes have emerged. The table below shows shifts in regional equity weightings over the past six months across American Funds equity-focused portfolios. The shifts represent any allocations of 1% or greater during the period. Emerging markets exposure has been added across strategies, while European exposure has generally been increased and the reverse has been true with regard to U.S. exposure.

Number of American Funds With Greater Than 1% Shift in Exposure

Regional shifts of 1% or greater over past 6 months among 18 equity and multi-asset funds. Rows do not add to 18 because not all funds had shifts reaching the 1% threshold.
As of 12/31/17.

Diversification

At this stage of the cycle, ensure portfolios are well diversified, with the flexibility to pivot to select areas of opportunity.

Core Holdings

Maintain a core allocation to U.S. equities but consider rebalancing toward international and emerging market equities.

Rebalancing

Asset Allocation Themes

The asset allocations below are drawn from the 13 American Funds model portfolios, which are established by Capital Group’s Portfolio Oversight Committee. The committee, a team of experienced portfolio managers, makes strategic allocations to underlying American Funds based on stated investment objectives. The themes that follow are reflected in the asset allocations:

Put These Insights to Work in Portfolios

Source: Capital Group. As of 12/31/17.
*Annualized standard deviation is calculated at net asset value based on monthly returns and is a measure of how returns over time have varied from the mean. A lower number signifies lower volatility.

U.S. Equity

Maintain a core allocation of U.S. equities but market levels call for selectivity and rebalancing toward international and emerging market equities.

International Equity

Seek meaningful exposure to international and emerging market equities for the potential to gain from Europe’s improving health and rising consumer purchasing power in emerging markets.

Fixed Income

Seek to construct core bond portfolios that are positioned for rising volatility, with limited exposure to lower quality credit or high yield, which can provide relative stability and diversification.

Fixed Income Themes

How might the insights within this 2018 Outlook be reflected in the fixed income allocation of an investment portfolio? Considering a portfolio that contains 60% equities and 40% fixed income, here is how one might construct a fixed income allocation using funds from American Funds.

How to Upgrade Your Bond Portfolio

A Balanced Approach to Your Fixed Income Allocation

Sources: Capital Group, JPMorgan, Standard & Poor’s.
Data is a weighted average of the funds in the model approach and is as of December 31, 2017. U.S. equity index proxy used is Standard & Poor’s 500 Composite Index. Correlations based on F-2 share class results.1 The model approach is hypothetical and for illustrative purposes only. Allocations, holdings, yields and other data shown do not reflect an actual portfolio. Advisors should tailor client recommendations to their individual circumstances.2 American Funds Emerging Market Bond Fund does not yet have three years of returns, so the correlation used in the example above is calculated from the first full month after its 7/29/2016 F-2 share class inception through 12/31/2017. Because this is a relatively short period of time, its correlation of -0.29 is more representative of market movements over this period than what is typically seen from this asset class. Over a longer term basis we expect its correlation will likely be closer to that of its blended benchmark (50% J.P. Morgan GBI-EM Global Diversified Index and 50% J.P. Morgan EMBI Global Diversified Index). If the benchmark correlation of 0.39 over the three years ending 12/31/2017 were used in example above, the overall correlation would increase to 0.0.3 Taxable equivalent rate assumptions are based on a federal marginal tax rate of 37%, the top 2018 rate. In addition, we have applied the 3.8% Medicare tax.

To seek diversification for your broader portfolio from equities, consider a 20% weighting using The Bond Fund of America at its core. Tax-aware investors might want to consider The Tax-Exempt Bond Fund of America as an alternative. For a measure of capital preservation, consider a 5% weighting to the Intermediate Bond Fund of America, which yields somewhere between 2% and 2.5% for a three-year duration. Tax-aware investors might consider Limited Term Tax-Exempt Bond Fund of America.

To seek a measure of enhanced income, consider a 10% allocation to American Funds Emerging Markets Bond Fund. Tax-aware investors might opt to invest in American High-Income Municipal Bond Fund. Finally, consider a 5% allocation to American Funds Inflation Linked Bond Fund to seek a measure of inflation protection. The portfolio had a yield of 3.4%, 5.5 years of duration and zero correlation to the equity market for the three-year period ended December 31, 2017.

For tax-aware investors at the highest tax bracket, swapping out the funds for tax-exempt counterparts results in a portfolio that had a tax-equivalent yield of 5.2% with 6 years of duration and correlation to equities of —0.2 for the three years ended December 31, 2017.

Disclosure

Investments are not FDIC-insured, nor are they deposits of or guaranteed by a bank or any other entity, so they may lose value.

Investors should carefully consider investment objectives, risks, charges and expenses. This and other important information is contained in the fund prospectuses and summary prospectuses, which can be obtained from a financial professional and should be read carefully before investing.

Statements attributed to an individual represent the opinions of that individual as of the date published and do not necessarily reflect the opinions of Capital Group or its affiliates. This information is intended to highlight issues and should not be considered advice, an endorsement or a recommendation.

Content contained herein is not intended to serve as impartial investment or fiduciary advice. The content has been developed by Capital Group, which receives fees for managing, distributing and/or servicing its investments.